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How do Agency Problems Affect the Implied Cost of Capital?

Author

Listed:
  • Ching-Chih Wu
  • Tung-Hsiao Yang

    (Department of Finance, National Chung Hsing University, No. 250, Kuo Kuang Rd., Taichung 40227, Taiwan)

  • Bing-Huei Lin

Abstract

We test the relationship between the implied cost of capital and two agency problems, free cash flows and overinvestment. We show that free cash flows have a significant negative impact on the implied cost of capital, but overinvestment has a significantly positive impact. In addition, the pay-for-performance sensitivity has a negative effect but the sensitivity of volatility has a significantly positive effect on the implied cost of capital. After taking the incentives into account, we find that the significance of the impact from both agency problems still exists. Finally, we conclude that well-designed executive compensation should focus on reducing overinvestment and the sensitivity of volatility.

Suggested Citation

  • Ching-Chih Wu & Tung-Hsiao Yang & Bing-Huei Lin, 2016. "How do Agency Problems Affect the Implied Cost of Capital?," Journal of Reviews on Global Economics, Lifescience Global, vol. 5, pages 210-226.
    • Handle: RePEc:lif:jrgelg:v:5:y:2016:p:210-226
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    File URL: http://www.lifescienceglobal.com/independent-journals/journal-of-reviews-on-global-economics/volume-5/85-abstract/jrge/2297-abstract-how-do-agency-problems-affect-the-implied-cost-of-capital
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    Cited by:

    1. Diana Hashim Syarif & Sugeng Wahyudi & Irene Rini Demi Pangestuti, 2019. "Financial Constraints and Cost of Equity: Empirical Study of Shariah Compliant Firms in Indonesia," Research in World Economy, Research in World Economy, Sciedu Press, vol. 10(3), pages 371-381, December.

    More about this item

    Keywords

    Agency problems; Free cash flows; Overinvestment; Implied cost of capital.;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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